a) Company PLU decides to issue bond to finance its investment in a project. However, the project is only expected to start to generate income from year 4 onwards.Considering this, which of the following bonds is favoured by the company? Please explain your answer. Plain vanilla bond Step-up coupon bond Deferred coupon bond Credit linked coupon bond
- (a) Company PLU decides to issue bond to finance its investment in a project. However, the project is only expected to start to generate income from year 4 onwards.Considering this, which of the following bonds is favoured by the company? Please explain your answer.
- Plain vanilla bond
- Step-up coupon bond
- Deferred coupon bond
- Credit linked coupon bond
(b) An affirmative covenant is most likely to stipulate:
1) Limits on the issuer’s leverage ratio.
2) How the proceeds of the bond issue will be used.
3) The maximum percentage of the issuer’s gross assets that can be sold.
(c) Suppose a bond’s price is expected to decrease by 3% if its market discount rate increases by 50 bps. If the bond’s market discount rate decreases by 50 bps, the
- 3%
- Less than 3%
- More than 3%
What is the best terminology to describe this pattern (use terminology covered in this unit)? Please explain your answer.
(d) Assume that bonds ABC and XYZ are zero coupon bonds. The yield curve for this issuer is flat at 8%.
One bond has a maturity of 8 years whilst one has a maturity of 10 years. Based on this information, which bond is the longer maturity bond and which is the shorter maturity bond.
What is the best terminology to describe this pattern (use terminology covered in this unit)? Please explain your answers.
|
|
Estimated percentage change in price if interest rates change by: |
|
|
|
-50 basis points |
+50 basis points |
|
Bond ABC |
+10% |
-7% |
|
Bond XYZ |
+11% |
-8% |
(e) A floating rate issue has the following coupon formula:
Three-month LIBOR + 20 basis points with a cap of 1.80% and a floor of 1.50%
The coupon rate is reset every quarter. Suppose that at the reset date the three-month LIBOR is as shown below. Compute the coupon rate for the next quarter:
|
|
1-year Treasury rate |
Coupon rate |
|
1st reset date |
1.65% |
|
|
2nd reset date |
1.40% |
|
|
3rd reset date |
1.25% |
|
|
4th reset date |
1.10% |
|
|
5th reset date |
1.35% |
|
(f) A bond that is characterized by a fixed periodic payment schedule that reduces the bond’s outstanding principal amount to zero by the maturity date is best described as a:
- Bullet bond
- Plain vanilla bond
- Fully amortized bond
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